The Customer Owned Banking Association (COBA) has lodged a submission with the Australian Prudential Regulation Authority (APRA) for its final round of consultation on the revised capital framework, asking APRA to ensure that the standardised capital framework is a “genuine competitive alternative” to the internal ratings-based approach (IRB) framework used by the major banks.
The association has also called for “genuine transparency” for comparisons of capital between standardised and IRB banks.
The submission has followed APRA’s announcement in December 2020 that it is consulting on proposed changes to the authorised deposit-taking institution (ADI) capital framework.
APRA proposed “improvements” to the framework to enhance the ability of the framework to respond to “flexibly to future stress events”, improve the “transparency of ADI capital strength”, and embed “unquestionably strong” levels of capital.
Under the proposed revisions, banks may have to hold a large share of their required capital as “buffers”.
APRA is also recommending that banks implement more risk-sensitive risk weights, particularly for residential mortgage lending (due to the extent of mortgage lending on bank balance sheets in Australia).
Furthermore, APRA is also looking to reduce risk weights for small-business lending in order to provide additional incentives for banks to lend to SMEs.
As such, in its submission, COBA said that APRA should ensure that the calibration of overall capital requirements does not increase capital requirements for standardised ADIs.
“Any disproportionate increase on standardised ADIs will further erode the competition-enhancing benefits from reducing the gap,” the submission said.
Commenting on COBA’s submission to APRA, CEO Michael Lawrence noted that APRA’s rules on capital are “critical” to allowing for a “competitive, contestable and diverse” banking market.
He also said that this would mark a significant change to a “foundational element” of the prudential regime.
“This affects everything, from the pricing of home loans to our sector’s capacity to grow and innovate to meet customer needs,” he said.
“An uncompetitive standardised capital framework will harm consumer choice and competition.
“The vast majority of banks are subject to the standardised framework. Existing banks who make the transition to IRB status are few and new entrant IRB banks are non-existent. The market is starting to see increasing consolidation and this hollowing out of the ‘middle’ and the consolidation of smaller ADIs reduces diversity and raises questions about competition and choice.”
COBA referenced the 2014 Financial System Inquiry (FSI) report, which it said found that the gap between average IRB and standardised mortgage risk weights means that IRB banks can use a smaller portion of equity funding on mortgages than standardised banks.
The FSI report said: “Because equity is a more expensive funding source than debt, this translates into a funding cost advantage for IRB banks’ mortgage businesses to the extent that the riskiness of mortgage portfolios is similar across banks. Given that mortgages make up a significant portion of the assets of almost all Australian ADIs, competitive distortions in this area could have a large effect on their relative competitiveness.”
The report added that this could include inducing smaller ADIs to focus on higher-risk borrowers.
Mr Lawrence concluded: “We recognise that APRA has come a long way in addressing unfair regulatory capital settings since the 2014 Financial System Inquiry recommended action.”
The new framework is proposed to be implemented from 1 January 2023.